Review Questions 8
Textbook Page Questions
295 2
296 8, 10, 13
297 16, 18, 19, 22
298 24
Solutions
2. a. Average cost = $1.75 million / 1 million = $1.75/burger
b. Average cost = $2.25 million / 2 million = $1.125/burger
c. The fixed costs are spread across more burgers — thus the average cost falls.
8. At the break-even level of sales, which is 60,000 units, profit would be zero:
Profit = 60,000 (2 – variable cost per unit) – 20,000 – 10,000 = 0
Solve to find that variable cost per unit = $1.50
10. a. Accounting break-even would increase because the depreciation charge will be higher.
b. NPV break-even would decrease because the present value of the depreciation
tax shield will be higher when all depreciation charges can be taken in the first
five years.
13. If CF = 0 for the entire life of the project, then the PV of cash flows = 0, and project NPV
will be negative in the amount of the required investment.
16. Figures in
Thousands of Dollars
Sales $16,000
Variable cost 12,800 (80% of sales)
Fixed cost 2,000
Depreciation 500 (includes depreciation on
new checkout equipment)
= Pretax profit 700
Taxes (at 40%) 280
= Profit after tax $ 420
+ Depreciation 500
= Cash flow $ 920 a. Cash flow increases by $140,000 from $780,000 (see Table 8.1) to $920,000. The
cost of the investment is $600,000. Therefore,
NPV = –600 + 140 annuity factor (8%, 12 years)
= –600 + 140 7.536 = $455.04 thousand = $455,040
b. The equipment reduces variable costs from 81.25% of sales to 80% of sales. Pretax
savings are therefore 0.0125 sales. On the other hand, depreciation charges increase
by $600,000/12 = $50,000 per year. Therefore, accounting profits are unaffected if
sales equal $50,000/.0125 = $4,000,000.
c. The project reduces variable costs from 81.25% of sales to 80% of sales. Pretax
savings are therefore .0125 Sales. Depreciation increases by $50,000 per year.
Therefore, after-tax cash flow increases by
(1 – T) (Revenue – Expenses) + T (Depreciation)
= (1 – .4) (.0125 Sales) + .4 50,000
= .0075 sales + 20,000
For NPV to equal zero, the increment to cash flow times the 12-year annuity factor
must equal the initial investment.
cash flow 7.536 = 600,000
cash flow = $79,618
Therefore,
.0075 Sales + 20,000 = 79,618
Sales = $7,949,067
NPV break-even is nearly double accounting break-e

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